Demand for Money: 

There are three main motives behind the demand for money: 

• The transactions motive
• The speculative motive
• The precautionary motive

There is a trade off between holding cash and holding interest bearing assets. The demand for money is the demand for cash in hand. Money demand can be transactions demand for money, that is, money needed for transactions. The transactions demand for money depends on interest rates and the level of real GDP. As the interest rate goes up, less money will be kept in hand for transactions because there is more to be gained by converting it to a different interest bearing asset. The transactions movie is the desire to hold onto money for cash based transactions.

There are other reasons for choosing between holding cash and holding interest bearing assets. Household expectations and the relationship of interest rates to bond values can lead people to choose cash or other assets too. This is the speculative motive, in which people choose to hold cash because they want to be prepared for cash based investment opportunities. Both the speculative motive and transactions motive make the quantity of money demanded a function of the interest rate. Rising interest rates will reduce the quantity of money that firms and households want to hold, and falling interest rates will increase the quantity of money that firms and households want to hold. The precautionary motive describes people's inclination to hold onto money for unexpected cash expenses, such as medical bills or car repairs. These kinds of expenses often need to be paid immediately; less liquid assets are not much help. An increase in the level of output or the price level for a given interest rate increases the demand for money and shifts the money demand curve to the right, while a decrease in output or price for an interest rate shifts it leftwards.